In our previous videos we talked about using the lower of cost or market rule to value inventory. And in order to use the lower cost or market rule we first need to know what the market price was. And we use the middle value of the replacement cost, the net realizable value, or the net realizable value minus a normal profit. So of those three different values we chose the value in the middle, the middle value, to represent our market value and then we compared that to the original cost of the inventory and took the lower number and that was our inventory valuation. But we really didn't get a lot into a lot of detail about what net realizable value is.
And so I just want to walk you through briefly in this video an example so you see it understand. So our technical definition, we think about what net realizable value or NRV is, it's the expected sales price. So the sales price we are anticipating that we will get per unit or per for this inventory minus minus any costs that will be necessary to complete the sale and so costs we're talking about to complete the sale cost going forward right forget about the past just going forward any costs that are going to be necessary to get this inventory from the shelf into a customer's hand so for example a sales commission right so if we we're going to incur a sales commission cost for the unit or for selling a car or something we have to pay the person that sold the car then there's going to be a cost there to complete the sale. Also, if there's any kind of packaging cost or anything like that, if it's an item that we're going to be shipping.
So let's just walk through a quick example and make it a little easier to understand. So let's say that you have 100 units of inventory sitting on the shelves, and you expect, you think that you're going to sell this inventory for $25 a unit, right? So that's our expected selling price.
That's our expected sales price. And so now we need to know about costs necessary. to complete this sale and see if there's anything we need to deduct.
So you're going to have to pay $7 commission per unit to your salespeople, assuming that you sell this inventory, right? So you sell a unit for $25, you're going to incur a commission of $7, right? Now you also are going to incur a $1 unit in packaging costs, right?
$1 per unit in packaging costs. So now let's go ahead and calculate our net realizable value. So we're just going to take, again, this... expected sales price which in this case is $25 put parentheses here we have a lot so $25 and then we subtract we're gonna subtract out the cost to complete the sale so we've got the $7 commission so it's minus seven and then we've also got this one dollar per unit and packaging cost so minus one and then we just take that and we multiply that by And the reason be 100 because we have 100 units of inventory. So we want to get the total total net realizable value of all this inventory.
And that's going to be 1700. 1700. Because if we just think about it on a per unit basis, there's 25 minus 7 minus 1. We're going to have 17. So that's 17 is our net realizable value per unit, but we have 100 units. So our total net realizable value for this inventory. is 1700.